UBS Holds Sway as Chile Traders Embrace Rate Call

By Randall Woods -
Jan 17, 2013

UBS AG (UBSN)’s Rafael De La Fuente was
alone last month when he said Chilean interest rates would rise
in the first half, just as inflation slowed to a 2 1/2-year low.

Now, with wages rising four times faster than consumer
prices and joblessness at a record low, traders are starting to
embrace the most-accurate forecaster of Chilean monetary policy.
Two-year interest-rate swaps rose seven basis points in the past
month to 5.23 percent, indicating traders expect the key rate to
increase a quarter-point to 5.25 percent by July, Banco de Chile (CHILE)
said. A month ago, swaps implied no change until October.

De La Fuente’s more-aggressive call for a half-point
increase is being supported by the fastest economic expansion in
11 months in November and wage growth that surpassed cost-of-living increases by 5 percentage points. At De La Fuente’s 5.5
percent forecast, Chile’s interest rate would be the highest
since February 2009 and at least a full percentage point above
that of Mexico, Peru and Colombia.

“This is still an economy that looks tight to me in terms
of not having much excess capacity to work with,” De La Fuente,
ranked first among analysts based on a two-year history of rate
predictions complied by Bloomberg, said by telephone from
Stamford, Connecticut. “This is an economy that will need to
find a way to cool off domestic demand.”

Central bank officials weren’t available to comment on
monetary policy because the bank is in a quiet period before
today’s meeting, communications director Luis Alvarez said in an
e-mail.

Falling Unemployment

The jobless rate fell to 6.2 percent in the three months
through November, the lowest level since Chile’s government
changed its methodology in 2010.

De La Fuente was the only economist among 13 forecasters
surveyed by Bloomberg last month who said rates would rise in
the first six months of the year.

Deutsche Bank AG, the only other firm to anticipate an
increase in 2013, said the rate would increase a half-point in
the fourth quarter. Three predicted a rate cut.

“Every day there are more reasons for us to worry about
inflation,” Rodrigo Aravena, the chief economist at Banchile
Inversiones and the second-ranked forecaster, said by telephone
from Santiago. “Our primary risk scenario is for inflation to
be higher than forecast with the central bank raising rates.”

Aravena, who didn’t participate in the December survey,
says his baseline estimate is for rates to remain unchanged this
year. The odds of rates increasing this year have increased as
economic growth exceeds analyst estimates, he said.

Beating Forecasts

In a January poll by the central bank, traders and
investors anticipated a rate increase by January 2014, one month
after saying they wouldn’t rise until December next year.

Since the central bank published that poll on Dec. 12,
economic growth in Chile topped analysts’ estimates for the
fourth straight month and the unemployment rate fell 0.9
percentage point in November from the year earlier.

That will cause the inflation rate to double to 3 percent
within a year, according to traders surveyed by the bank.

Policy makers have kept the key rate unchanged at 5 percent
since February 2012 after making a quarter-point reduction in
January of that year. All analysts surveyed by Bloomberg,
including De La Fuente, expect the bank board to keep borrowing
costs unchanged today.

The bank publishes its decision after 6 p.m. local time.

Peso Strength

Chile already has the highest borrowing costs among major
rate-setting banks in Latin America apart from Brazil, which has
cut interest rates to 7.25 percent from 12.5 percent in July
2011. Colombia’s central bank also reduced rates in its past two
meetings to boost economic growth, while Peru and Mexico have
kept them unchanged.

Chile’s bank may be reluctant to increase borrowing costs
in the first half of the year because higher interest rates
could put more pressure on the peso, which has appreciated 5.1
percent against the dollar in the past 12 months, according to
Mario Arend, the chief economist at Celfin Capital SA.

“We don’t see any change in the interest rate in the short
term because of the impact it could have on the exchange rate,”
he said by telephone from Santiago. “The real exchange rate is
arriving at levels that are very similar to what we saw during
the last intervention.”

The bank board in January 2011 started a program to buy
dollars in the spot market to weaken the local currency after
the peso traded at 465.75 per U.S. dollar. The peso appreciated
0.3 percent to 473.66 per dollar at 9:11 a.m. in Santiago.

Rising Imports

For now, the peso hasn’t dented growth. The economy
expanded 1.3 percent from October on a seasonally adjusted basis
after gains in the service, mining and retail industries. The
growth, more than triple the median estimate, changed the
outlook of some analysts who now expect rates to rise sooner
than before, said Arend.

The expansion has thus far caused imports rather than
inflation to surge as consumers increase purchases abroad
without putting pressure on domestic prices, according to
Alfredo Coutino, Latin America director at Moody’s Analytics.

“The fact that inflation is declining doesn’t mean the
economy isn’t overheating,” Coutino said by telephone from West
Chester, Pennsylvania. “As pressures on domestic demand
accumulate, inflation will start a trend of acceleration
probably around May or June of this year, and that is going to
force the central bank to start hiking.”